||Ask the Small Biz Adviser
Last year's loss, this year's
Dear Small Biz Adviser:
In the first year of business, I produced about twice as many expenses
as I produced income. However, in the following year I will do better
than break even. Is there a way to deduct my losses from one year
to the earnings of the next?
You clearly indicate a strong sense of learning and finding every
possible means of creating a profitable business. Your request for
finding a means to save on tax payments this year for losses on
last year's net loss demonstrates how obstacles can be turned into
One very important assumption: You operate a corporation,
but I will consider proprietorship issues.
Yes, you can carry forward net operating losses from
a previous year. But there are limits, so pay attention to the details.
First, for the benefit of all readers, let us define
a net operating loss (NOL). Subtract all your deductions from gross
operating income. If the deductions are greater than the gross operating
income, you have a NOL.
- You cannot use the previous
year's NOL as a deduction when determining this year's NOL.
- If your company received any
dividends from any U.S.-based corporations, it can deduct -- with
restrictions -- 70 percent or 80 percent of those dividends from
the gross income. Consider the example offered by the IRS:
|Income from business
|Taxable income before special
|Minus: Deduction for dividends
received, 80 percent of $150,000
| Net operating loss
- If you are a public utility, dividends paid out
can be deducted from the gross income.
I don't suspect you are a public utility, but suggest
you review IRS
publication 542 to learn more specific details on each of the
three issues above.
Another limitation there is the matter of time. You
have up to 20 years over which to carry forward losses from a previous
year. Depending on your net profits in preceeding years, the amount
of loss you can apply is limited. Again, IRS publication outlines
General requirements for applying previous years'
- You actively participated in the operation of the
business. It is not sufficient that you were simply an investor.
- Your investment in the business is of a sufficient
- The business loss on Schedule C is sufficient to
offset income from any other sources.
Schedule K, Form 1120 is used to file the NOL in a
There are also issues related to closely held corporations.
There are five conditions defining that term, and publication 542
details those matters.
As you can obviously deduce from this column, there
are issues strongly suggesting the need to consult a tax accountant
to interpret the terms, conditions and procedures you need to apply
when using a NOL from the previous year. However, the expense incurred
consulting the accountant is also tax deductible.
This entire column has addressed corporations. As
you can see the details and issues are significant of content to
warrant an entire column. If, by chance, you are a proprietor, then
please view IRS
Publication 536 for NOL as a proprietor (download a free copy
Acrobat Reader to view the file).
-- Posted: Jan. 8, 2002